Home/Blog/Trading Ideas/After years of financial indigestion, restaurant stocks offer food for thought

After years of financial indigestion, restaurant stocks offer food for thought

17 December 2016 in Trading Ideas

Key Takeaways

  • Minimum wage increases only likely at local levels
  • Regulatory environment will become more favorable
  • Profitability is dependent upon larger economic factors

If there were ever any doubts about the U.S. restaurant industry’s recovery from the economic collapse of 2008, they should be put to rest on April 14, 2015. That day – as tens of thousands of low-wage workers prepared a massive strike to support an increase in the minimum wage to $15 per hour – the U.S. Commerce Department announced that Americans were spending more in restaurants and bars than grocery stores. [1] [2]

Trade groups and analysts have warned about the perils of higher wages affecting restaurant bottom lines for the better part of a year. But the truth is that opinions about the effect of a $15 minimum wage are quite mixed. A March 2016 study by the University of California at Berkeley’s Center on Wage and Employment Dynamics found that a proposed increase in the New York state minimum wage would boost pay by almost 25 percent for more than 3 million workers, with only negligible effects on employment and costs. [3] Meanwhile, the conservative Heritage Foundation anticipated in August that as many as 9 million jobs could be lost, with almost 1 million coming from Texas alone. [4]

The minimum wage debate, however, may soon be moot on a national level. The incoming Trump administration’s nominee to head the U.S. Labor Department, Andy Puzder, is chief executive of CKE Restaurants – parent company of Hardee’s and Carl’s Jr. Puzder, who has argued against raising the federal minimum wage beyond $9 per hour, will also have significant input into federal rules governing overtime pay, union organizing and workplace safety. [5]

Generational Shift

The nation’s 1 million restaurants also stand to catch a break from a potential repeal of the Affordable Care Act, better known as Obamacare. The landmark 2010 health care legislation required employers with 50 or more full-time employees to provide health insurance to 95 percent of workers. [6] Puzder, the incoming labor secretary, has claimed restaurants are losing business because the health insurance premiums have increased dramatically. The law, he said, “is the craziest thing in the world and does not make sense.” [7]

The restaurant industry’s own numbers, however, contradict many of its concerns. According to the U.S. Census Bureau, sales in September hit a record $55.4 billion. [8] Same-store sales in October were up 39 percent over a year earlier, and 35 percent of restaurant operators said they believe the economy will be better in six months. [9]

About the only potentially problematic policy issue for restaurants with the new Trump administration is the president-elect’s stated position on immigration. Since launching his long-shot White House bid, Trump has vowed a harsh crackdown on undocumented workers. About 1.4 million of the 12.7 million U.S. restaurant workers are immigrants; a 2008 Pew Hispanic Center survey estimated 20 percent of all cooks and one-third of all dishwashers are undocumented workers. [10] Removing those employees from the workforce likely would wreak havoc on many small- to medium-sized establishments.

The most promising number for restaurants, however, may be 80 million – as in, the population of the Millennial Generation, or people born between 1982 and 2000. [11] Millennials, according to the National Restaurant Association, “view dining out as a social event … They tend to favor fast food, deli food and pizza restaurants over coffee shops, high-end dining and casual dining. Their diversity and interest in new things draw them to more ethnic restaurants, too.” [12]

Appetizing Brands

It’s a hopeful long-term thought for some of the nation’s largest fast-food operators, such as YUM! Brands (YUM), which owns Kentucky Fried Chicken, Pizza Hut and Taco Bell; Restaurant Brands International (QSR), owner of Burger King and Tim Hortons; and Domino’s Pizza (DPZ). Analysts at Morgan Stanley found that McDonald’s (MCD) is not only recession-proof, but is also the most-visited restaurant by the Millennial generation. [13] [14]

Even so, the outlook may be more promising for restaurants that have positioned themselves to take advantage of healthy dining options, such as Panera (PNRA) and Chipotle (CMG). While Chipotle has struggled to overcome a dive in revenues caused by an E. coli outbreak in summer 2015, the company’s commitment to local food sourcing and GMO-free ingredients, as well as an effective online advertising campaign, makes it likely to thrive over the long term. [15] [16]

Casual dining stocks may not fare as well over the long term, although a number of restaurants have surprised investors with strong, double-digit returns over the past year. Darden Restaurants (DRI), which owns the Olive Garden and Longhorn Steakhouse chains, has gained about 40 percent over the past year; Cheesecake Factory (CAKE) has done almost as well. Even investors in Denny’s (DENN), where stock has risen by one-third over the past year, are feeling satisfied.

Even on the low end of the growth curve, restaurant stocks are likely to be a good bet as the Millennial generation ages. Already, the typical Millennial spends an average of $2,921 annually of a food budget – about 44 percent — on dining out, almost $300 more than the average Baby Boomer. [17]

Motifs:

Eating Out

Junk Foods

Seven Deadly Sins

Sources: [1] Janos, Adam. “Fast Food Minimum Wage Push Takes to the Streets of New York City,” Wall Street Journal, April 15, 2015.

[2] Jamrisko, Michelle. “Americans’ Spending on Dining Out Just Overtook Grocery Sales for the First Time Ever,” Bloomberg, April 14, 2015.

[3] Reich, Michael, et al. “The Effects of a $15 Minimum Wage in New York State,” University of California Berkeley, Center on Wage and Employment Dynamics, Institute for Research on Labor and Employment, March 2016.

[4] Sherk, James. “How $15-per-Hour Minimum Starting Wages Would Affect Each State,” Heritage Foundation, August 17, 2016.

[5] Trottman, Melanie; Jargon, Julie; and Bender, Michael. “Trump Picks Fast-Food Executive Andy Puzder as Nominee for Labor Secretary,” Wall Street Journal, December 8, 2016.

[6] Filloon, Whitney. “Why Trump’s Victory Gave Restaurant Stocks a Boost,” Eater, November 10, 2016.

[7] Fernandez, Henry. “Obamacare is Bankrupting Restaurants, CEO Warns,” Fox Business News, November 2, 2016.

[8] DeNale, Rebecca. “Advance Monthly Sales for Retail and Food Services, October 2016,” U.S. Census Bureau, November 15, 2016.

[9] National Restaurant Association. “Restaurant Economic Snapshot,” November 2016.

[10] McCarthy, Amy. “Will the Restaurant Industry Survive Stricter Immigration Screenings?” Eater, March 4, 2016.

[11] U.S. Census Bureau. “Millennials Outnumber Baby Boomers and Are Far More Diverse, Census Bureau Reports,” June 25, 2015.

[12] National Restaurant Association. “Manage My Restaurant: Marketing to your millennial audience,” 2016.

[13] Gutierrez, Carl. “McDonald’s Recession-Proof Menu,” Forbes, November 10, 2008.

[14] Lutz, Ashley. “Millennials are telling a big lie about McDonald’s,” Business Insider, March 24, 2015.

[15] Zuraw, Lydia. “A Timeline of Chipotle’s Five Outbreaks,” Food Safety News, December 15, 2015.

[16] Wahba, Phil. “Chipotle’s E. Coli Hangover Lingers as Sales Plunge Again,” Fortune, July 21, 2016.

[17] Talty, Alexandra. “New Study Finds Millennials Spend 44 Percent of Food Dollars on Eating Out,” Forbes, October 17, 2016.

 

*